I’m confused. I’ve heard both a radio and a television commercial for fee-based financial advisers that claim they “only benefit when I benefit.” What does that mean? Don’t I have to pay them whether I make money or not? —Matt

Dear Reader,

Incredible. You just hit on my biggest pet peeve in investment management marketing. If you don’t pay attention closely, the ads will have you believing that when you lose money, then your adviser doesn’t make any money at all. Nothing could be further from the truth.

Matt, let’s give you a hypothetical portfolio worth $500,000, which is being managed by your investment adviser Beverly. Since Beverly is a fee-based adviser, you are to pay her one percent of your total portfolio value each and every year. One percent is a rather standard fee in the wealth management industry, and typically, you pay the fee on a quarterly basis, which complicates the math a bit, but don’t worry. I’ll do it for you. If your portfolio value is $500,000 at the end of the first quarter, then your fee would be $1,250. Now, you can either pay the fee out of the account, or you can pay the fee out of your own pocket. Before we move on, it makes a difference as to how you pay your fee each and every quarter. If you pay out of the account, it will stifle your growth. If you pay out of pocket, while it certainly reduces your discretionary cash flow, it allows your money to grow without taking a tiny step backward each quarter.

For the sake of our moment here together, let’s say your account value increases by 2.5 percent per quarter this year. To make the math palatable, I’m begging you to let me show that as a 2.5 percent increase each quarter. Your $500,000 grows to $512,500 by the end of the first quarter. And because your adviser "only makes more money when you make more money,” Beverly’s fee increases to $1,281.25. If this same pace were to continue for four quarters and you paid the fees out of pocket, your end of the year balance would be $551,906.45. You made $51,906.45, and for that, you paid her $5,320.41 for the year. Or a fee increase of an annualized $320.41 from the previous year. Not too shabby.

I’d make that trade if for some reason it were that easy to selectively make that trade. Under this positive scenario, no one would ever complain. Who are we kidding? Of course, people will complain. People complain about getting too many fries at McDonalds.

Everything is sunny when it’s sunny. Sometimes it’s not sunny.

As witnessed by, well, reality, the market isn’t always going to end-up up for the year. Sometimes the market ends down, as does your portfolio. Yes, your adviser's job is to smooth out the bumps, and at times, generate positive returns when the market is otherwise falling, but that doesn’t always go as planned. So instead of your $500,000 gaining you 2.5 percent per quarter for one year, let’s assume it goes the other direction and loses 2.5 percent per quarter for one year. Your new account value at the end of the first quarter is $487,500. And your fee at the end of the year is only $1,218.75. Accounting for the whole year of losses and fees at that pace, you will have lost $48,156.05 and it would have cost you $4,695.22 in fees to do so. You know that emoji that’s gritting its teeth? It seems appropriate here.

Don’t get me wrong, Beverly did her job. That’s a tough pill to swallow when you’re writing the quarterly checks totaling $4,695.22, but she did perform a year worth of services. And to be fair, it wasn’t necessarily her fault that you lost money. Maybe the market lost 6 percent per quarter, and she limited your losses to 2.5 percent per quarter. If that were the case, then maybe you send a dozen cookies with the check for the quarterly management fee.

Year two comes and goes, and your portfolio ends the year up 2.5 percent per quarter. If you chose to pay Beverly’s fees out of the account, which I generally frown upon, then your balance at the beginning of year two would be $447,342. The 2.5 percent quarterly account increase by the end of the year would result in an ending account balance of $488,862.99, and of course, your fee would increase too.

If you paid your fee out of the account balance again, after two years, you will have paid $9,419.91 in fees and your portfolio will have lost $11,137.01 of value. The “we only make more money when you make more money” assertion, while 100 percent true, feels pretty darn empty. Primarily because advisers make money when you lose money too.

I’m not suggesting an adviser shouldn’t get paid what they’re paid. I’m simply suggesting the “we only make more money when you make more money” rationale is insincere at best and misleading at worst. The right adviser can bring tremendous value to you and your finances, but the integrity of the relationship can be immediately compromised based on the language an adviser uses to try to get you to walk through the door.

Have a question for Pete the Planner? Email him at AskPete@petetheplanner.com or visit petetheplanner.com.

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